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One of the big problems facing U.S. commercial banks back in the 1970s was disintermediation caused by the Federal Reserve's Regulation Q. Reg Q limited the interest rates that banks could pay on their savings accounts and time deposits. The problem was that from time to time interest rates climbed above the Reg Q ceilings, usually because of increasing rates of inflation. Depositors naturally transferred their savings out of the banks and into money market mutual funds, which were not constrained by a rate ceiling.

The banks finally got regulatory relief. In June 1980, commercial banks were allowed to issue 6-month money market certificates (MMCs) that paid the 6-month T-bill auction rate plus 25 basis points. On Monday, August 25, 1980, the T-bill auction rate was 10.25%. Would an investor rather have put $50,000 into a T-bill that paid 10.25% or an MMC that paid 10.50%? Let's assume there was no difference in credit risk because the MMC was covered fully by government deposit insurance.

Obviously, the naive person (one who has not studied bond math) thought that 10.50% on the MMC was a better deal than 10.25% on the T-bill. What the commercial banks did not advertise was that their 10.50% was an add-on rate set by adding 25 basis points to the T-bill auction rate, which in turn was quoted on a discount rate basis. To make an apples-to- apples comparison, it is essential to convert the 10.25% discount rate to an add-on basis. Assume that the number of days was 182 and that both rates were for a 360-day year. Using the conversion formula 1.8, the equivalent add-on rate for the T-bill was 10.81%.

The investor clearly should have chosen the T-bill. Not only was the rate of return significantly higher (10.81% compared to 10.50%), the interest income on the T-bill was exempt from state taxes while the MMC was taxed.

The Monetary Control Act of 1980 officially phased out Reg Q for traditional savings accounts over the following six years, but the constraint effectively was gone because of the newly authorized types of deposits, such as MMCs, which paid going market rates. Also, the T-bill auction rate back then was the weighted average of the accepted competitive bid rates submitted by securities dealers. Successful bidders paid different prices based on their own bid (discount) rates. That created a problem known as the “winner's curse” – those who bid more aggressively paid higher prices for the very same security. In 1998, the Treasury adopted a single-price auction for all maturities whereby all successful bidders pay the same price based on the highest accepted rate. You might not remember, but 1980 was a year of incredible, unprecedented swings in market rates. The 6-month T-bill auction rate was 15.70% on March 28, down to 6.66% on June 20, and back up to 15.42% on December 19. That was some serious interest rate volatility!

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